Zombie Economics and Just Deserts: Why the Right Is Winning the Economic Debate

01/07/2011 06:54 pm ETUpdated
May 25, 2011

Economist Paul Krugman recently decried "zombie economics," policies advocated by "free-market fundamentalists [who] have been wrong about everything yet now dominate the political scene more thoroughly than ever." I share his chagrin, but suggest that the problem is that Krugman was wrong to also assert that "economics is not a morality play." In fact, I believe that defeating the zombie-like resilience of laissez faire capitalism will require directly refuting the moral belief in the inherent fairness of free market outcomes.

Consider a recent suggestion by Harvard economist Greg Mankiw, former Chairman of George W. Bush's Council of Economic Advisors, that tax policy should be based on a "Just Deserts Theory" under which "people should get what they deserve." This principle, a restatement of Equity Theory, proposed by psychologist John Adams in 1963 to explain how people evaluated distributional fairness, has long played a central role in tax debates, and is one that I, like many liberals, heartily endorse. Indeed, I think that widespread support for free markets is based more on belief in their inherent morality than on belief that they promote economic growth, potentially explaining the religious fervor of free-market fundamentalists defending their faith despite the considerable counter-evidence provided by recent events.

Mankiw concisely summarizes the theory underlying the ethical argument for market capitalism: "under a standard set of assumptions... the factors of production [i.e., workers] are paid the value of their marginal product... One might easily conclude that, under these idealized conditions, each person receives his just deserts." Mankiw's long-standing opposition to higher taxes on the wealthy suggests that he thinks these conditions usually pertain in the real world, too.

Consider me skeptical. The list of "standard assumptions" open to question is long, but two are particularly problematic (Northwestern economist Jonathan Weinstein has critiqued several others). First, how can we be sure that marginal productivity is the same as social contribution? A safe cracker in a criminal gang may indeed receive loot equal to his marginal productivity, but this doesn't mean that he is creating social wealth. Thus, financial industry profits accounted for over 40 percent of all corporate profits in 2004-5, but does anyone seriously contend that Wall Street created (rather than redistributed) 40 percent of wealth during that period?

The second problem is one that Mankiw himself acknowledges when he comments that the dramatic growth in income at the very top of the economic pyramid might be thought of as a lottery, with a few lucky winners reaping the lion's share of rewards. As economists Robert Frank and Philip Cook point out in their book The Winner Take All Society, technological change and ever-larger markets have caused small differences in ability, effort or luck to translate into large differences in income. Economic theory says that such "tournament rewards" create an incentive for individuals to exert maximal effort, consistent with just deserts as long as you don't mind that "losers" get much less despite trying nearly (or just) as hard. But theory also says that tournament rewards create an incentive for people to sabotage the efforts of others and to take on as much risk as possible. Given the role that excess risk played in Wall Street's meltdown, this is hardly a ringing endorsement for the fairness (or efficiency) of free market outcomes.

So Mankiw's "easy" conclusion that markets deliver just deserts depends critically on his own moral intuition about what is just. Given humanity's well-known ability to convince ourselves that what is in our own self-interest is fair, it is hardly surprising that wealthy conservatives like Mankiw would believe that free market capitalism delivers fair outcomes. But it is noteworthy that in one real-world situation with tournament rewards -- lotteries -- society typically imposes taxes in excess of 50 percent, since winners pay regular income taxes on earnings already halved by the governmental sponsor's share of the pot.

Moreover, a large body of laboratory research investigating moral intuitions regarding the division of a pool of money has demonstrated the powerful appeal of an equal split, a preference consistent with anthropological evidence that hunter-gatherer groups are remarkably and consistently egalitarian. While a handful of studies have demonstrated that preferences for equality in the laboratory are (slightly) reduced when subjects have to earn the money at stake, this involves experimenters (who provide the money in the first place) making it clear that they consider the earner to have made a commensurate contribution in the laboratory setting.

So, sure, people like just deserts when there is compelling evidence that they are indeed just. But the egalitarianism of hunter-gatherers, whose groups undoubtedly included considerable and obvious variation in individual abilities, suggests that the standard of proof for justifying inequality can be quite high.

I therefore think it likely that conservative icon Joe the Plumber favors lower taxes not simply because his own personal experience suggests that smarter and harder-working plumbers (granted, he isn't actuallya plumber) tend to provide better services and to have proportionately higher incomes as a result, but also because authorities like Mankiw assert that a complicated mathematical theory says that this intuition is true throughout the economic system. To be sure, populist Joe might claim to disdain elite theory, but as Keynes once observed, "practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist."

Thus, Tea Party advocates sustain their belief in the market's fairness by blaming the government for bailing out Wall Street and interfering with the market's ethical magic, explaining why their initial targets were Republicans who supported the bailout (like Mankiw). Meanwhile, Democrats have completely failed to link higher taxes on the wealthy to populist anger at those who prospered while driving the economy into a ditch. To regain the initiative, I believe, progressives must directly challenge the claim that unfettered markets create just deserts. This won't be easy. Free market fundamentalists have the advantage of a simple message -- ending bailouts will deliver just deserts -- and of nearly limitless funds from rich folks who benefited from the bailout but are happy to claim that it should never happen again.

Let me therefore suggest one way to start: replace the estate tax with an inheritance tax. Republicans use the term "death" tax to imply that society is confiscating a lifetime of just deserts wealth. But if taxes are to be based on Mankiw's proposal that those "who contribute more to society deserve a higher income that reflects those greater contributions," then inheritors who have contributed nothing themselves should pay substantially higher rates (full disclosure: I am myself an inheritor).

I believe a debate about inheritance taxes will allow us to distinguish two arguments that appear similar but are critically different. The claim that people should get their just deserts is tricky to implement, but offers a valid moral principle to guide public debate. But the closely related argument that government should "keep its hands off my money" represents pure selfishness by people who refuse to acknowledge that public goods like education and defense are essential for the creation and protection of private wealth. Progressives have to make clear that the attempt to eliminate taxes on inheritors suggests that conservatives believe that all-you-can-eat socialism is fine for the rich as long as there is just-deserts capitalism for everyone else.